The securities and investment industry is concerned with the management of money through the purchase, sales, financing and combination of assets, which have, among other properties, security, earnings, or potential for gain in value. Such assets generally include stocks and bonds, along with other investment vehicles, such as options, futures, foreign currency exchange, funds, derivative instruments and others. Common stocks provide holders with an ownership interest in an entity and thereby an opportunity to share in the entity's appreciation. Over the course of the recent bull market, common stocks have provided attractive returns and because of that are favored by many investors. However, in certain situations direct ownership may not provide the most efficient way to obtain exposure to common stock because of tax and various regulatory considerations. For example, certain industries are limited as to the type of investment holdings they can have or are required to hold a large amount of regulatory capital against certain investments and thus in some cases may be constrained in their ability to gain exposure to common stock through direct ownership. In some cases it is not desirable to carry large equity holdings on the books, because of accounting constraints. The sale of highly-appreciated assets, on the other hand, is associated with significant tax liability. In addition, while stocks provide solid performance over long periods, it is generally desirable to reduce the short-term uncertainty of their investment returns, which is due to normal fluctuations in the stock price. This is especially important for long-term investors who are subject to an accounting regime that requires them to reflect unrealized short-term losses and gains.
As investment vehicles, bonds, especially high-quality bonds such the U.S. Treasury bonds, provide considerably higher security than stocks and feature steady and predictable income flow along with certain regulatory and accounting advantages. Especially in recent years, however, Treasury bonds have not generally demonstrated a potential for appreciation as common stocks did. In extended bull markets, such as that experienced in the past decade, this can lead to significant disadvantages in terms of the overall return on a given investment. It is thus apparent that selecting one investment vehicle over another in any particular situation can lead to very different results, and in any event should involve a careful balance of investment, tax and accounting considerations.
Financial institutions have created new instruments to re-engineer financial products to meet investors' tax, accounting and investment needs. One approach that has been used in the past is to contribute different assets to created trusts. This approach has been used to customize the character of their investment holdings. One example of financial products created on this basis are equity liked trusts (“ELTs”). Broadly, an ELT is a special-purpose investment vehicle that gives ownership interest in different equity/debt instruments and can provide certain desirable tax and accounting treatments. Prior art ELTs differ in some aspects, but often have a bond component that limits the downside potential, i.e., protects the principal, and an equity component that may take the form of a call option for realizing an upward potential. This combination is associated with certain accounting benefits, because from a capital perspective it is often preferable to own debt (i.e., to have interest in the ELT), as opposed to equity. However, ELTs generally have no redemption option, they generally don't make interim distributions, which limits their utility.
Another example of prior art financial instruments is provided by the equity linked notes (“ELN”). In general, ELNs are debt instruments issued by third parties giving equity exposure, sometimes via coupons, sometimes through indexation of principal, or other indexation. Thus, a coupon-linked instrument might be structured as a two-year principal-protected bond that pays upside on the S&P 500 index, but nothing if the S&P 500 index doesn't go up. Equity linked notes often trigger certain adverse tax and accounting consequences and, in any event, provide credit exposure to the issuer. A trust, on the other hand, often is structured to provide pass-through taxation and credit exposure only to the underlying assets.
Another structure that has been used is provided by the premium exchangeable participating shares, or “PEPS” introduced in 1995, or similar products known under the acronyms DELs, PRIDES or ACES. The PEPS trust is a short-term (3¼-year) trust established to purchase and hold a portfolio of stripped U.S. Treasury securities maturing on a quarterly basis, and American Depositary Shares (ADSS) representing shares of common stock of a Japanese company (in this case Amway Japan Limited). Holders of the PEPS have the right of quarterly distributions and at the end of the term could receive the underlying ADSS subject to certain downside potential conditions. While structurally PEPS are similar to, for example, ELTs it is important to note that they serve a completely different purpose, which is to get out of an investment position (i.e., to monetize an existing position), as opposed to obtain exposure to it. Further, PEPS have no redemption rights and provide no tax and accounting advantages as discussed below.
Other prior art products exist, but none of them provides all of the bundle of rights included in the ProEquity product of this invention. ProEquity was created to provide institutional investors (primarily insurance companies) with equity exposure in a tax-efficient and accounting-efficient manner, using a computerized reporting and management system.
In the following description of the preferred embodiments occasional reference is made to structures and terms that are known in the prior art. In this regard the interested reader is directed to the disclosure of the following U.S. patents, which are incorporated herein by reference for all purposes: U.S. Pat. Nos. 4,346,442; 4,674,044; 4,677,552; 4,823,265; 4,953,085; 5,038,284; 5,101,353; 5,126,936; 5,132,899; 5,189,608; 5,210,687; 5,227,967; 5,262,942; 5,270,922; 5,644,727; 5,682,466; 5,905,974 and 5,946,667.